Ch 25 Problems & Questions
If the Fed wants to increase the money supply with open-market operations, what does it do?
If the Fed wants to increase the money supply it will buy bonds from the government to create money.
What are reserve requirements? What happens to the money supply when the Fed raises reserve requirements?
Reserve requirements are the required number of reserves each bank must hold against deposits. When the Fed raises reserve requirements, the reserve ratio increases, which lowers the money multiplier, so banks can loan out less of each dollar that is deposited. As a result, this will decrease the money supply.
Assume that the banking system has total reserves of $100 million. Assume also that required reserves are 10% of checking deposits and that banks hold no excess reserves and households hold no currency. What is the money multiplier? What is the money supply? If the Fed now raises required reserves to 20% of deposits, what are the change in reserves and the change in money supply?
The money multiplier is 10 and the money supply is $1000 million. The money multiplier is 5, reserves are $100 million, money supply is $500 million. Money supply decreases and reserves remain unchanged.
Does the repayment of a loan Citibank previously took from the Fed increase or decrease the money supply? Explain.
We do not know the effect on the money supply because we do not know the discount rate on the loan.
What distinguishes money from other assets in the economy?
Money is a unit of account, a medium of exchange, and a store of value. What makes money unique from other assets in the economy is its liquidity, or the ease with which an asset can be converted into the economy's medium of exchange.
Does the Fed's purchase of bonds in open-market operations increase or decrease the money supply? Explain.
The Fed's purchase of bonds in open-market operations increases the money supply because banks will have more reserves and will be able to loan more. As banks loan more, the money supply increases.
Does the Fed's reduction of the reserve requirement increase or decrease the money supply? Explain.
The Fed's reduction of the reserve requirement will lower the reserve ratio, which will raise the money multiplier, and increase the money supply.
Who is responsible for setting monetary policy in the US? How is this group chosen?
The Federal Open Market Committee is made up of seven members appointed by the President and approved by the Senate to set monetary policy in the US
Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Use T-accounts to show the effect of this transaction on your uncle and on TNB. Has your uncle's wealth changed? Explain.
The uncle's wealth has increased since he is no longer in debt to Tenth National Bank.
The economy of Elmendyn contains 2000 $1 bills. If people hold all money as currency, what is the quantity of money? If people hold all money as demand deposits and banks maintain 100% reserves, what is the quantity of money? If people hold equal amounts of currency and demand deposits and banks maintain 100% reserves, what is the quantity of money? If people hold all money as demand deposits and banks maintain a reserve ratio of 10%, what is the quantity of money? If people hold equal amounts of currency and demand deposits and banks maintain a reserve ratio of 10% what is the quantity of money?
$2000 $2000 $2000 $20,000 $3636.36
Bank A has a leverage ratio of 10, while Bank B has a leverage ratio of 20. Similar losses on bank loans at the two banks cause the value of their assets to fall by 7%. Which bank shows a larger change in bank capital? Does either bank remain solvent? Explain.
9.3--> Bank A 18.6 --> Bank B 0.7<1.4 --> Bank B shows a larger change in bank capital. Bank A remains solvent because its bank capital only falls by 0.7, which is a nominal change.
Why don't banks hold 100-percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?
Banks don't hold 100-percent reserves because they want to create money. It is more profitable to hold reserves as loans, which earn interest than to leave the money as reserves, which earn no interest. The number of reserves banks hold is related to the amount of money the banking system creates through the money multiplier. The smaller the fraction of reserves the bank holds, the larger the money multiplier, because each dollar of reserves creates more money.
What is commodity money? What is fiat money? Which kind do we use?
Commodity money is money with intrinsic value, such as gold, whereas fiat money is money with no intrinsic value, such as dollar bills. We use fiat money.
What are demand deposits and why should they be included in the stock of money?
Demand deposits are deposits that can be accessed on demand by writing a check. They should be included in the stock of money because they can be used as a unit of account, a store of value, and a medium of exchange.
You take $100 you had kept under your mattress and deposit it in to your bank account. If this $100 stays in the banking system as reserves and if banks hold reserves equal to 10% of deposits, by how much does the total amount of deposits in the banking system increase? By how much does supply increase?
Deposits increase by $1000 because the money multiplier is 10, but currency drops by $100 so the money supply increases to $900.
Suppose that the reserve requirement for checking deposits is 10% and that banks do not hold any excess reserves. If the Fed sells $1 million of government bonds, what is the effect on the economy's reserves and the money supply? Now suppose the Fed lowers the reserve requirement to 5%, but banks choose to hold another 5% of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?
If the Fed sells $1 million of government bonds, the money supply will decrease and lower reserves by $1 million. Banks might choose to hold another 5% of deposits as excess reserves for daily actions such as making change or cashing checks. The money multiplier and money supply are not affected.
Assume that the reserve requirement is 5%. All other things being equal, will the money supply expand more if the Fed buys $2000 worth of bonds or if someone deposits in a bank $2000 that she had been hiding in her cookie jar? If one creates more, how much more did it create?
Money supply will expand if the Fed buys $2000 worth of bonds. Both deposits will lead to monetary growth, but the deposit of Fed is new money whereas the $2000 from the cookie jar is already in the money supply. The $2000 worth in bonds will create $2000 more in the money supply.
Why can't the Fed control the money supply perfectly?
The Fed does not control the amount of money that households choose to hold as deposits in banks and the Fed does not control the amount that bankers choose to lend. So, the amount of money in the economy depends in part on the behavior of depositors and bankers, which is why the Fed cannot control the money supply perfectly
Assume that the reserve requirement is 20%. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Fed decides that it wants to expand the money supply by $40 million. If the Fed is using open-market operations, will it buy or sell bonds? What quantity of bonds does the Fed need to buy or sell to accomplish the goal?
The Fed will buy bonds if they want to expand the money supply because this will increase the money multiplier and lower reserves. Fed must get 8 million bonds because 40 million * 0.2 = 8 million.
Does the Fed's increase of the interest rate it pays on reserves (discount rate) increase or decrease the money supply? Explain.
The Fed's increase of the discount rate reduces the money supply because a higher discount rate discourages banks from borrowing reserves from the Fed, which reduces the quantity of reserves in the banking system, which will reduce the money supply.
What is the discount rate? What happens to the money supply when the Fed raises the discount rate?
The discount rate is the interest rate on the loans that the Fed makes to banks. When the Fed raises the discount rate, the quantity of reserves decrease, so the money supply decreases.
The Fed conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10%, what are the largest and smallest possible increases in the money supply that could result? Explain.
The largest possible increase is $100million since the money multiplier is 10 for a $10 million open-market. The smallest possible increase would be $10 million if the bank keeps all money as reserve surpluses.
If people hold less currency due to a rash of pickpocketing, does the money supply increase or decrease?
This decreases the money supply because the demand for money decreases.
When the FOMC increases its target for the federal funds rate, does the money supply increase or decrease?
This increases the money supply because it in increases the rate at which banks lend reserve balances to other banks overnight, increasing the amount of money available in the economy.
If bankers decide to hold more excess reserves due to a fear of bank runs, does the money supply decrease or increase?
This increases the money supply because there is more money available in the economy to loan out.
Which of the following are considered money in the US economy? Which are not? Explain your answers by discussing each of the three functions of money. a) a US penny b) a Mexican peso c) a Picasso painting d) a plastic credit card
a) a US penny is money in the US economy because it is a unit of account, a medium of exchange, and a store of value. b) a Mexican peso is money in the US economy because it is a unit of account, a medium of exchange, and a store of value. c) a Picasso painting is not money in the US economy because it is not a unit of account, even though it is a medium of exchange and a store of value. d) a plastic credit card is not money in the US economy because it is a delayed payment, which therefore means it is not a medium of exchange nor a store of value.
Happy Bank starts with $200 in bank capital. It then accepts $800 in deposits. It keeps 12.5% of deposits in reserve. It uses the rest of its assets to make bank loans. What is Happy Bank's leverage ratio? Suppose that 10% of the borrowers from Happy Bank default and these bank loans become worthless. Show the bank's new balance sheet. By what percentage do the bank's total assets decline? By what percentage does the bank's capital decline? Which change is larger? Why?
leverage ratio=4 declined by 10%, bank capital declines 10%. change is equal
Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10%. Now suppose that BSB's largest depositor withdraws $10 million in cash from her account. If BSB decides to restore its reserve ratio by reducing the number of loans outstanding, show its new T-account. Explain what effect BSB's action will have on other banks. Why might it be difficult for BSB to take the action described in part (b)? Discuss another way for BSB to return to its original reserve ratio.
loans=$216 million Other banks will receive fewer reserves and reduce their loans. It may be difficult for BSB to reduce loans in a short period of time because banks cannot force people to pay back their loans immediately. Another way for BSB to return to its original rserve ratio is to take more deposits to get more reserves, or borrow from the Fed or other banks.
